Experts

The world’s experts on all topics are huddling in Washington, D.C. One chap proclaims that he is the world’s ranking expert on goldfish. Inquires a layman, “Okay, how do you tell a male goldfish from a female goldfish?”

Says the expert, “I can tell you as an expert that the male goldfish eats male worms and the female goldfish eats female worms.” The layman then harrumphs, “Alright, how do you tell a male worm from a female worm?”

Shouts the expert, “Hey, I’m an expert on goldfish! I never said I was an expert on worms!”

Purported experts are in the news these days. Late last month, in nominating Ben Bernanke to a second term as head of the Federal Reserve, the president gushed that the economist was “an expert.” It gave me the shivers, but I’ll get into that later.

First, some local examples of experts at work. The Motley Fool recently looked at the predictions of self-professed experts (securities analysts) on the future of San Diego’s telecom superstar, Qualcomm. Fourteen analysts estimated long-term yearly earnings growth. The estimates ranged from 7 to 22 percent. Big spread. The price targets on the stock were from $30 to $63. Qualcomm was selling at $47 then; this means that by following the experts, you could experience anything from a loss of 36 percent to a gain of 34 percent.

One of today’s most contentious donnybrooks among economics experts is whether markets are rational. The so-called efficient market hypothesis is at the center of this battle. The idea is that the decisions of millions of rational investors, all trying to outsmart one another, provide the best judge of a stock’s or bond’s value. Prices on exchanges instantly and accurately reflect the best available information on the assets. Ergo, you can’t beat the market.

San Diegan Harry Markowitz, when a graduate student at the University of Chicago in the 1950s, basically started the efficient market hypothesis going as he applied mathematical concepts to the subject of risk. (Faculty member Milton Friedman, later to become one of the most eminent economists of the 20th Century, cracked that he wasn’t sure stock market theory belonged in the study of economics.) Markowitz, now an adjunct professor at the Rady School of Management at the University of California San Diego, was soon joined by other economists, and the theory of rational markets evolved into a near religion. Markowitz won a Nobel Prize.

Almost all the experts preached the theory, but it has come under fire because of the one-day crashes in 1987 and 2008, the dot-com/tech collapse of 2000–2002, and the current bear market, along with the real estate bubble and implosion. A new book by Justin Fox, The Myth of the Rational Market, tears apart the academics who stumped for the theory, sometimes making big bucks in the process. After the 1987 crash, Yale economist Robert Shiller, who has an excellent track record in forecasting the economy, called the efficient market hypothesis “one of the most remarkable errors in the history of economic thought.”

So which expert d’ya believe?

The British royalty demands performance from its experts. Last November, Queen Elizabeth visited the London School of Economics to inquire why none of its experts had anticipated the financial devastation. Chastened, a group of Britain’s most eminent economists wrote her a letter, confessing that they were guilty of “wishful thinking combined with hubris.” Figuratively bowing to the queen, they stated, “In summary, your majesty, the failure to foresee the timing, extent, and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”

Of course, the same sins are attributable to America’s self-pronounced experts. Bernanke is now lauded for keeping us out of another Great Depression by flooding the system with liquidity: keeping interest rates inordinately low, bailing out financial institutions, in effect dumping money out of airplanes. But Bernanke took his post in 2006 and did not foresee the tsunami. He couldn’t see any housing bubble. In March of 2007 he said that the subprime mortgage problems were contained. Prior to the week of September 15, 2008, Bernanke again assured Americans that housing problems were limited and under control. Then he suddenly turned tail and declared that Treasury Secretary Henry Paulson’s $700 billion bailout for the banking industry was critically necessary to save the world economy. Among the newspapers denouncing opponents of the bailout was the Union-Tribune.

Alan Greenspan, Bernanke’s predecessor, proclaimed that central bankers can’t foresee or forestall bubbles. During the Clinton administration, Greenspan, Arthur Levitt, Robert Rubin, and Lawrence Summers led the effort to repeal the Glass-Steagall Act of 1933, which for decades had separated bankers and brokers and kept runaway greed at least partly in check. Then the same foursome made sure that derivatives, those extremely complex financial instruments that now threaten to bring down the whole financial system, be nonregulated.

Oh yes. Greenspan and Summers, along with the late Ken Lay of the late Enron, lectured then–California governor Gray Davis about the cause of the state’s 2000 energy crisis. It was excessive regulation, Greenspan, Summers, and Lay claimed, reminding the governor of their expertise. Summers is now President Obama’s key economics advisor.

And Greenspan? You can say this for him: he admitted his mistakes — well, sort of. Last year, he told a House committee, “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.” He had put too much faith in the ability of markets to self-correct. And quite frankly, he had never understood the tyranny of greed or the omnipresence of crooks. He had not learned the lesson that most of us learn from our mothers: “Don’t do it just because everybody else is doing it.” That’s how derivatives became a multitrillion-dollar nightmare. Banks were making money in this extremely risky business. “If others are doing it, we must too, so our profits can keep pace,” said the experts who ran the financial institutions.

Comments

I think there may be a fundamental problem with trying to proactively regulate a system that is so complex, nobody fully understands it. At best, it seems like all we can do is reasonably react to the current state of the market. The market will continue evolving as people discover new inefficiencies to exploit and I just don't know if anybody is up to the challenge of understanding it all. I think the average person wants to take comfort in believing that there's someone at the helm who has the knowledge and control over the market to steer the boat, but I personally don't think that's even possible.

Ben Bernanke = Claims as of yesterday that the recession/depression is over- (as Joe Wilson said to Obama in the Joint Session, “Liar!”)

Alan Greenspan = "Mr. Bubble"

Henry Paulson = Another Goldman Sachs yahoo.

These are now the only people who run the government's finances, all over paid, greedy, yahoo graduates of the Harvard Business School who work on Wall Street at the elite firms and self deal all day long-and basically brough our country to the edge of collapsing.

OK, I gave my little rant. More news. Michael Moore was on the "Jay Leno Show" last night and he has a new movie coming out on October 1, 2009. And before anyone gets on an anti-liberal MM is a commie bandwagon let me say this- he suppsoedly goes after BOTH parties in thsi new movie and really brings to light all this hanky panky going on in the financial services sector and Washington and Washington's attempts to regulate the financial services sector.

Anyway, Leno saw the movie and said it is very balanced and not like the previous two “documentaries" that were certainly made with a bias from the start- although I did like “Sicko” and “Fahrenheit 9/11”.

New movie is called “Capitalism: A Love Story” and I will go see it the day it opens.

Response to post #2: I read about Moore's latest movie. There is a new Gordon Gekko film coming out, too. I enjoyed the first Gekko film and have also enjoyed three or four Moore films: Roger and Me, Sicko and Fahrenheit 9/11. There was a good one about guns and Columbine but I am wondering if that was Fahrenheit 9/11. Or was it a different one? Best, Don Bauder

4: Bowling for Columbine dealt with guns, and Fahrenheit 9/11 with the government bungling of 9/11.

First off, great article! Really enjoyed it, and I think you'd have more fun being a Goldfish expert than an advisior to Obama right now--not the easiest job in the world! So here's my take.

The only thing that was being traded was default risk. Why would they (AIG) worry about managing it? To good to be true ratings on shady MBS's from Moody's = less capital set aside and astronomical leverage. Voila!!!!

Eveyone freaked, bubble broke, companies died overnight, big players bought the CDS protection (synthetic short sale) knowing, encouraging, and excited that these companies were going to zero and then were made whole and very rich.

So Don, how do you feel about the talk of the credit market risks and Asset Backed Securities (ABS) that are floating around loaded with auto loans, credit card debt, student loans, and home equity loans?

With so many out of work, prime for default, and losing their jobs in large numbers, wouldn't that be the next inevitable crisis looming?

Let me know what you think!

And buy my one page book entitled "Don't buy things you can't afford."

Nassim Taleb came up with a successful investment strategy based on a human psychological observation. That investment strategy has worked out very well for him so far, but that doesn't in any way make him an expert or qualified to be the Treasury Secretary. Plus, the guy is completely full of himself.

I did see four Moore films. Bowling for Columbine, dealing with guns, came out in 2002. I enjoyed it, as I enjoyed the others. Best, Don Bauder

By dbauder

I really enjoyed “Sicko” and “Fahrenheit 9/11”, but the Columbine movie was just too biased in the anti firearm propaganda. He made some good points but it was very biased-like all anti gun advocates- and was too over the top in it's bias.

I am pro 4th Amendment-even though I own no firearms. I believe everyone has the right to arm themselves for self defense.

I look forward to the new MM move on October 1. Too bad you live in CO Don, we could get the crew here together and all of us could go see it opening night.

Fred: But with Taleb, I was left with the feeling that while he's certain about what is/was wrong (and I don't argue with him about that), he had very little to say about what was right, or even better. If you listen to (or have listened to) both hours of the podcasts, this is the most striking peculiarity in Taleb's interviews.

Keeping in mind that Roberts is a Hayekian, I've listened to him talk to strict Keynesians and reach some sort of common ground, or at least, some understanding that I could either agree with, disagree with, or ponder. With Taleb, there's no room for any of that. I found him to be pompous, and other than his reputed awesome portfolio (of which he refuses to share any broad notion of what his formula for investment is), I have no notion why he acts this way.

It makes it very difficult to understand exactly what direction he would move if he was in charge, only that it is assumed he would certainly move away from where we are currently.

Refried, one of the reasons I admire Taleb is precisely because he doesn't claim to know all the answers. That's his major point...we have to recognize the limits of our knowledge.

That said, he's very clear that eliminating VAR would go a long way in clarifying financial institutions' true exposure to risk. Just that one change would have immediate dramatic effects, involving short term pain, but giving us all a fighting chance of doing better in the future.

Remember, with the same Goldman Sachs crooks in charge as last year we've had zero reform of the system. All we've done is reward the ones who crashed the economy.

Don't be lulled by smarmy sweet talk. Taleb's angry for good reason...he was sounding the alarm for years and no one in government paid any attention.

Unbelievably, we're still not paying attention.

What's needed is a fundamental reassessment of our economic goals in this interconnected world. It's not a matter of just tweaking the system a bit to get things back to "normal".

Instead, we're going to get more of the same. This "crisis" isn't over...I doubt we're even in the middle yet. I predict yet another fall because NOTHING has has changed. Our so-called leaders keep repeating that we're out of the worst of it, but they're ignoring the massive debts still swirling around the system and the inevitable inflation that will follow the pumping of so much money into the system to pay off the crooks.

Until we deleverage, something Bauder and Taleb agree must be done, we're subject to the same risks as a year ago.

According to Taibbi (and Bauder) our government has been taken over by Wall Street. Since they're the ones truly in charge, Taleb will continue to be ignored or even vilified. That's a tragedy, and we're all going to pay the price.

Response to post #7: I think a blowup in securitized credit card debt may well ignite the next crisis. And remember, the securitized mortgage crisis is hardly over. It has just been covered up. Best, Don Bauder

Response to post #8: Yes, the idea of having the Federal Reserve being the major regulator of banks is repugnant. Nobody was more wrong about the onset of this crisis than Greenspan, Bernanke, and their underlings. Another suggestion: Nell Minow, daughter of Newt Minow, as head of the SEC. She would shake Wall Street up. Mary Schapiro is incapable of doing so. She is a long-time beltway hack -- part of the system that brought us to the brink. Best, Don Bauder

Response to post #10: There are a lot of people out there who saw this coming and should have been named to posts, had they wanted them: Joseph Stiglitz, A. Gary Shilling, James Grant, Henry Kaufman, Nouriel Roubini et al. If they were deemed too old or too honest to take a post, they should have been named as advisors. Best, Don Bauder

Response to post #12: Chaos theory is worth studying. Among the reasons: as this stock market spirals ridiculously because of the ocean of liquidity, there will be no pressure to reform Wall Street. Thus, we are setting ourselves up for another crash. Some big, unexpected trauma could touch it off. Best, Don Bauder

Response to post #14: A century ago, economists preached, "Don't buy what you can't afford." But once Keynesianism took root in the 1930s, the shibboleth became "Don't save; spend. Private virtue is public folly. Buy what you can't afford." Best, Don Bauder

Response to post #19: Hopefully, insurance companies will come under the microscope as this healthcare controversy goes on. Yes, they turn down applicants for so-called pre-conditions; they drop insured people after conditions arise; they don't pay claims as they should. Etc. This must all be thoroughly aired. It won't be. Best, Don Bauder

Response to post #25: We have not only rewarded the Wall Streeters who caused the crisis. We have rewarded the regulators who looked the other way, or were too dense to see the storm clouds gathering. Best, Don Bauder

Response to Post #1
I think there may be a fundamental problem with trying to proactively regulate a system that is so complex, nobody fully understands it.

I think there is a fundamental problem with having a system that is so complex nobody understands it! Like "Too big to Fail" a system or set of financial instruments that no one understands should not be allowed to exist.

Response to post #48: As I have said on this blog many times, the essence of white collar fraud is contrived complexity. Most derivatives -- particularly the noxious ones -- fall into that category. There should have been criminal prosecutions in some of the derivatives cases, just as there should have been criminal cases against individuals in big banks that hid liabilities offshore. And there should be criminal prosecution now in the cases in which big Wall Street firms, particularly Goldman Sachs, are using computers to makemassive trades 1/3 of a second before another market-moving trade is made public. That is front-running, and is illegal. Period. Institutions considered too big to fail should be broken up. No institution should be too big to fail. Bring back Teddy Roosevelt! Best, Don Bauder

SurfPuppy, am I going to have to pay back the 50K in loans or what? If I call them right now, will they be in a mood to negotiate?

By SDaniels

In a word, yes, you are going to have to pay back what you borrowed. But only what you borrowed-no unearned bogus fees and costs. If you borrwed X amount of dollars, make a decent living off of your degree and can pay the money back then you have a moral and legal obligation to do so.

The problem people are running into in SL's are the scams with the big companies like Sallie Mae, NelNet, First Marblehead and others, as well as private lenders, who are engaging in straight up fraud in many of the loans they service-like bumping interest rates above the contracted rate, intentionally forcing defaults when a person is unemplopyed or cannot make a payment for lack of work or enough pay if they are working, adding in bogus "collection fees and costs". That is where the fight is going in the student loan sector. Fighting the fraud that permiates it.

Oh, They will not negotiate any part of a student loan.

I am in a high level lawsuit with SLM right now, and it is going to be (hopefully) a watershed moment in SL scammimg.

He's not in a position to be a "fraudster." He doesn't have to try to distill unimaginably complex interactions to the general public to explain why their retirement funds are worth half as much as they were five years ago. The problem with putting anyone at the captain of this ship is that they will very quickly have to explain things that they can't possibly know. So either they lie to themselves and tell you the truth, or they lie to your face. Take your pick. Nobody will get to that position by telling the truth.

Additionally, Telab's in a position where people think he's a market expert due to his success. While I agree that his uniquely psychological investment strategy is sound and has worked out for him very well, I don't think he's any more of an expert than the million other people who share his opinion of what we should be doing with the market at this point in time. You don't have to go far to find someone who has been predicting this downfall for years now.

Response to #48:

I agree with this to some extent, but stifling complexity stifles innovation and growth. Furthermore, how much do you dumb/shrink/regulate it? It's a balancing act between speed of growth and safety, or greed and fear.

I don't have any problem with derivatives at all. I don't even have a problem with leverage, as long as you have the cash to back it. I feel like all these banks just went into the Wall Street casino and bet a bunch of money they didn't have. When the casino came to collect and the money wasn't there, the government had to hit the reset button. It's fun to argue about what would happen if we implemented the ideas of this expert or that for the reset button, but I don't think it matters too much in the long run. We won't ever get the right answer.

Response to post #53: I agree that the government will come to the rescue of Sallie Mae. Nobody knows that better than Sallie Mae. So I don't think it will be in a mood to negotiate on your loan. Best, Don Bauder

Response to post #55: Addressing your two points: how many so-called market "experts" have lasted? They're experts while their luck lasts, but then they inevitably take a pratfall. Second, you're not against leverage as long as people have the money to pay back the debts. This assumes that people and institutions have an inherent goodness and self-control that I don't believe exists. Heavy debt normally leads to speculation. When the government bails out the gamblers, we have a moral hazard problem. This is why we have set up ourselves for another big crash. When? Wish I knew. Best, Don Bauder

Hey SurfP, I should qualify: I am an honest borrower of student loans, and have always planned on paying them back. Unfortunately, I have health issues that have not let me make the most of my degree, and I can only teach part-time.

The problem with SM is that even though I remain a full-time student (maintaining matriculation), they find any little excuse to take me out of deferment and start charging the monthly payment. If my department forgets to cross a 't' or dot an 'i,' SM tells me I am going to go into default while my files are being updated, and that I'd better pay up. I end up paying school fees AND loans at the same time.

They are even more inflexible than credit card companies, and if they could, I'm sure they would @#$@#% with the APR, too. Thankfully, they have to stick to the rate I agreed on when I consolidated...right?

Response to post #61: That is the purpose of this blog: giving 'em hell. We don't observe the kindness normally granted the feminine gender, which means that Fannie Mae and Sallie Mae get whacked as much as Freddie Mac. Best, Don Bauder

They are even more inflexible than credit card companies, and if they could, I'm sure they would @#$@#% with the APR, too. Thankfully, they have to stick to the rate I agreed on when I consolidated...right?

By SDaniels 9

Yes, Sallie Mae is inflexible because they can do things no other creditor in America can do-for the time being anyway.

People who get sick, or have other health problems, or lose employment, are very good examples of how the system can be manipulated by the loan holder.

Although there are applications to discharge SL debt for serious illness, it is rarely granted.

Sallie Mae WANTS to default your loan-so they can front load 40% of your loan balance as "collection costs and fees"-without actually incurring any collections costs ( I bet you didn't think that was legal-did you).

After they front load that 40% of bogus fees and costs they will then try to force you into one of the income contingent, 25 year repayment loans (requiring you to affirm all the bogus costs and fees). Then the meter keeps ticking, and if you make it to the end of the 25 years you will have an IRS tax bill bigger than your student loan.

Elizabeth Warren is working with Obama on many, many things-one of which is the SL problem. She was a law professor at Harvard Law School that had written extensively on the student loan problems-so I predict reform in Obama's first term on SL's, as well as several other issues Warren is working on (one of which is holding Timothy Geithner accountable for TARP funds).

CA used to have a program for teachers called APLE, where the state paid back a portion of SL's for teachers under specified conditions-you may want to look into that if you have not already.

LAST-I would double check the interest rate you consolidated with, to a current loan statement. It is VERY common for Sallie Mae to raise this rate above the contracted rate-usually .5 to 1.5 points above. That would be a 25% increase on a 6% rate.

Also keep an eye on any charges they add in for a forebearance or deferrment too.

Response to post #64: I had a friend (age 88 at the time, now deceased) who had all his money tied up in Fannie Mae paper. I told him I had done a computer search of all the currently outstanding paternity suits against him. It was amazing: Fannie Mae Calhoun of South Carolina, Fannie Mae Beauregard of New Orleans, Fannie Mae Cohen of the Bronx, and finally, Fanne Mae Foxe of Washington, D.C., the stripper known as Fanne Foxe who more than 30 years earlier had ruined the career of former Speaker of the House Wilbur Mills, who also had a booze problem. My friend replied, "My lawyers assure me that I have meritorious defenses in every one of those paternity suits." He also thought Fanne Foxe was too old to get pregnant by that time. He may have been too old to make any of them pregnant, but he wouldn't admit that. Best, Don Bauder

Response to post #65: This is very, very interesting information on Sallie Mae. It's one controversy I have only followed a bit. I can see now that I will have to bone up on what appears to be the Sallie Mae scam. Best, Don Bauder

OOPS! AND MORE ON WILBUR MILLS. I erred in post #66: Wilbur Mills was not Speaker of the House. He was chairman of the House Ways and Means Committee from 1957 to 1975 and was known as the "most powerful man in Washington." He entered a few Democratic primaries in the 1972 presidential race, but did poorly. In the mid-1970s, he was intoxicated and driving erratically with Fanne Foxe (an Argentine stripper) in the car. The cops stopped Mills and Foxe (who actually had another name), jumped into the Tidal Basin to escape arrest. But there was a scandal, of course. Another time, seemingly drunk, Mills accompanied Foxe's husband to Fanne's backstage dressing room, and there held a press conference. He resigned as chairman of the committee and soon left Congress. He went through AA and spent the rest of his life helping alcoholics. He died in 1992. During the scandal period, the joke was "She had the ways and he had the means." Best, Don Bauder